I periodically get inquiries from individuals who think they can avoid income taxes because they have a trust. Trusts are often very good tools to protect your assets; but not always a good tool for simple tax planning strategies. Trusts generally have much lower deductions, compressed marginal tax rates, and a much lower threshold for the net investment income tax. Thus, a trust may incur higher income taxes than an individual may pay.
Here are some tax considerations when evaluating a trust.
In most cases, estate and non-grantor trust income pays taxes like an individual, with the following main differences:
Trusts and estates (other than bankruptcy estates) do not get a standard deduction.
These trusts and estates get an exemption, but only $100, $300, or $600
Trusts and estates do get a deduction for trust income distributed to the beneficiaries, which is computed based on the actual distribution amount, distributable net income (DNI), and net accounting income
Trusts and estates do have the same progressive tax rates as individuals, with the exception of the lowest 10% rate bracket, which exists only for individual taxpayers. However, compared with those of individual taxpayers, the tax brackets are very compressed, with the highest marginal tax rate of 39.6% starting at $12,500 in taxable income for 2017.
Complex trusts and estates do not have a limitation for charitable contribution deductions from gross income.
Simple trusts cannot make charitable contributions
The net investment income tax applies to trusts and estates based on a threshold at the highest tax bracket and not on a fixed dollar amount.
The top rate of 20% for net long-term capital gains and qualified dividends applies when income reaches the top marginal bracket for ordinary income of 39.6%; due to the relatively compressed brackets, this means the 20% rate goes into effect if taxable income of trusts and estates exceeds $12,500 in 2017.